INSURANCE AND RISK MANAGEMENT

UNIT 1
Insurance; meaning – nature – scope – functions – principles of insurance – insurance in india –
emerging scenario.
Meaning of Insurance
an arrangement by which a company or the state undertakes to provide a guarantee of
compensation for specified loss, damage, illness, or death in return for payment of a specified
premium.
Definition:

D.S. himself word “ Insurance is defined as a social device providing financial compensation for the
effects of misfortune, the payment being made from the accumulated contribution of all parties
participating in the scheme.

What is Insurance?
Represented in a form of policy, Insurance is a contract in which the individual or an entity gets
financial protection, in other words, reimbursement from the insurance company for the damage (big
or small) caused to their property.
The insurer and the insured enter a legal contract for the insurance called the insurance policy that
provides financial security from future uncertainties.
In simple words, insurance is a contract, a legal agreement between two parties, i.e., the individual
named insured and the insurance company called insurer. In this agreement, the insurer promises to
help with the losses of the insured on the happening contingency. The insured, on the other hand,
pays a premium in return for the promise made by the insurer.
The contract of insurance between an insurer and the insured is based on certain principles, let us
know the principles of insurance in detail.

Principles of Insurance
The concept of insurance is risk distribution among a group of people. Hence, cooperation becomes
the basic principle of insurance.
To ensure the proper functioning of an insurance contract, the insurer and the insured have to
uphold the 7 principles of Insurances mentioned below:

• Utmost Good Faith

• Proximate Cause

• Insurable Interest

• Indemnity

• Subrogation

• Contribution
 • Loss Minimization

Let us understand each principle of insurance with an example.

Principle of Utmost Good Faith
The fundamental principle is that both the parties in an insurance contract should act in good faith
towards each other, i.e. they must provide clear and concise information related to the terms and
conditions of the contract.
The Insured should provide all the information related to the subject matter, and the insurer must
give precise details regarding the contract.
Example – Jacob took a health insurance policy. At the time of taking insurance, he was a smoker
and failed to disclose this fact. Later, he got cancer. In such a situation, the Insurance company will
not be liable to bear the financial burden as Jacob concealed important facts.
Principle of Proximate Cause
This is also called the principle of ‘Causa Proxima’ or the nearest cause. This principle applies when
the loss is the result of two or more causes. The insurance company will find the nearest cause of
loss to the property. If the proximate cause is the one in which the property is insured, then the
company must pay compensation. If it is not a cause the property is insured against, then no
payment will be made by the insured.
Example –
Due to a fire, a wall of a building was damaged, and the municipal authority ordered it to be
demolished. While demolition the adjoining building was damaged. The owner of the adjoining
building claimed the loss under the fire policy. The court held that fire is the nearest cause of loss to
the adjoining building, and the claim is payable as the falling of the wall is an inevitable result of the
fire.
In the same example, the wall of the building was damaged due to fire, fell due to a storm before it
could be repaired, and damaged an adjoining building. The owner of the adjoining building claimed
the loss under the fire policy. In this case, the fire was a remote cause, and the storm was the
proximate cause; hence the claim is not payable under the fire policy.
Principle of Insurable interest
This principle says that the individual (insured) must have an insurable interest in the subject matter.
Insurable interest means that the subject matter for which the individual enters the insurance
contract must provide some financial gain to the insured and also lead to a financial loss if there is
any damage, destruction, or loss.
For example – the owner of a vegetable cart has an insurable interest in the cart because he is
earning money from it. However, if he sells the cart, he will no longer have an insurable interest in it.
To claim the amount of insurance, the insured must be the owner of the subject matter both at the
time of entering the contract and at the time of the accident.
Principle of Indemnity
This principle says that insurance is done only for the coverage of the loss; hence insured should not
make any profit from the insurance contract. In other words, the insured should be compensated the
amount equal to the actual loss and not the amount exceeding the loss. The purpose of the
indemnity principle is to set back the insured in the same financial position as he was before the loss
occurred. The principle of indemnity is observed strictly for property insurance and does not apply to
the life insurance contract.
Example – The owner of a commercial building enters an insurance contract to recover the costs for
any loss or damage in the future. If the building sustains structural damages from fire, then the
insurer will indemnify the owner for the costs to repair the building by way of reimbursing the owner
for the exact amount spent on repair or by reconstructing the damaged areas using its authorized
contractors.
Principle of Subrogation
Subrogation means one party stands in for another. As per this principle, after the insured, i.e. the
individual has been compensated for the incurred loss to him on the subject matter that was insured,
the rights of the ownership of that property go to the insurer, i.e. the company.
Subrogation gives the right to the insurance company to claim the amount of loss from the third party
responsible for the same.
Example – If Mr. A gets injured in a road accident, due to the reckless driving of a third party, the
company with which Mr. A took the accidental insurance will compensate the loss that occurred to
Mr. A and will also sue the third party to recover the money paid as claim.
Principle of Contribution
The contribution principle applies when the insured takes more than one insurance policy for the
same subject matter. It states the same thing as in the principle of indemnity, i.e. the insured cannot
make a profit by claiming the loss of one subject matter from different policies or companies.
Example – A property worth Rs. 5 Lakhs is insured with Company A for Rs. 3 lakhs and with
company B for Rs.1 lakhs. The owner in case of damage to the property for 3 lakhs can claim the full
amount from Company A but then he cannot claim any amount from Company B. Now, Company A
can claim the proportional amount reimbursed value from Company B.
Principle of Loss Minimisation
This principle says that as an owner, it is obligatory on the part of the insurer to take necessary steps
to minimize the loss to the insured property. The principle does not allow the owner to be
irresponsible or negligent just because the subject matter is insured.
Example – If a fire breaks out in your factory, you should take reasonable steps to put out the fire.
You cannot just stand back and allow the fire to burn down the factory because you know that the
insurance company will compensate for it.
Nature of insurance
Contract
Insurance is a contract between two parties in which one party agrees to
protect the other party from losses in exchange for a premium. The parties
are insurers and insured. The insurer guarantees compensation in the
occurrence of any contingency to the insured and the insured pays a
premium to the insurer for protection. Insurance companies accept the offer
made by the insurance policyholder and enter into a contract. The
insurance contract is always in writing.

Lawful Consideration
The existence of lawful consideration is a must for an insurance contract
like any other lawful contract. The insurance policyholder is required to pay
premiums regularly to the insurance company. This premium is paid in
exchange for protection against losses and damages guaranteed by
insurance companies.

Payment On Contingency
The insurer is required to compensate the insured only on happening of contingency for
the damages and losses done. The insured cannot make a profit from the insurance
policy but can only claim compensation from the insurer in case of contingency. If no
contingency occurs, the insurer is not required to pay any compensation to the insured.

Risk Evaluation
The insurer evaluates the risk associated with the subject matter of the insurance
contract. Proper risk evaluation enables the insurer to calculate the right amount of
premium to be paid by the insured. The insurer uses different techniques for risk
evaluation. If the insurance object is subject to heavy losses, a heavy premium will be
charged. On the other hand, if there is less expectation of losses then a low premium
will be charged.

A large Number Of Insured Persons

There are large numbers of insured person’s takes insurance policy from the insurer.
The larger the number of insurance policyholders with insurance companies, the smaller
will be the degree of risk for any individual. Risk arising from any contingency is shared
among these large numbers of insured persons.

Co-Operative Device
Insurance is a cooperative device to pool risk among a large number of persons.
Insurance is a platform where different persons come together to share risk by taking
insurance policies from the insurer. All persons pay premiums regularly to insurance
companies. If any person incurs losses or damages due to the occurrence of any
contingency, the insurance company will compensate him out of premiums paid by
different persons.

Not A Charity Or Gambling

Insurance is a legal contract. It cannot be termed as a charity or gambling.
Compensation paid to the insured by the insurer is not in charity but is paid in exchange
for a premium deposited by him. Insured pays a premium to the insurer for a guarantee
of compensation in happening of the contingency. Also, the insured cannot make a profit
out of the insurance policy, and is meant for recovering from losses only. He is paid
compensation only when he incurs losses due to contingency. That is why it is not
gambling.

Types of functions of Insurance

The functions of Insurance have been given as follows, divided into Primary functions of
Insurance and Secondary functions of Insurance.
1. Primary Functions of Insurance
The primary functions of Insurance are:

• Protection and safety

The key function of insurance is to safeguard against the possibility of loss. The time and
amount of loss are unpredictable, and if a risk occurs, the person will incur a loss if they do not
have insurance. Insurance ensures that a loss will be paid and thereby protects the insured from
suffering. Insurance cannot prevent a risk from occurring, but it can compensate for losses
resulting from the risk.

• Provide safety and security

Insurance provides financial support and decreases the risks that come with doing business
and living. It ensures safety and security in the event of a specific incident. The basic function of
insurance is to safeguard against future hazards, accidents, and vulnerabilities in this way. No
insurance can prevent a risk from existing or prevent future catastrophes, but it can undoubtedly
assist you by providing coverage for the hazard's misfortune.

• Collective Risks
People purchase insurance policies to protect themselves from tragedy. Regardless, not every
one of them is subjected to bad luck regularly. Only a few people contribute to insurance. Each
member of the general public who receives protection pays an annual premium to the reserve.
People who are victims of hazards are compensated according to the insurance policy
conditions, which helps them meet their financial demands during a challenging period.

• Risk Assessment
Insurance companies assess the level of risk by looking at the numerous factors that contribute
to a chance. The procedure of determining premium rates is also based on the policy's risks.

• Certainty of payment
Insurance gives payment certainty in the event of a loss. Better planning and administration can
help to lessen the risk of loss. In risk, there are various sorts of uncertainty. Will the danger
occur, when will it occur, and how much loss will there be? In other words, the occurrence of
time and the amount of loss are both unpredictable. All of these concerns are removed through
insurance, and the insured is guaranteed money in the event of a loss.
2. Secondary Functions of Insurance
There are several secondary functions of Insurance. These are as follows:

• Financial Assistance
When you have insurance, you have guaranteed money to pay for the treatment as you receive
proper financial assistance. This is one of the key secondary functions of insurance through
which the general public is protected from ailments or accidents. Individuals look for insurance
with lower premiums since it’s more affordable. Thus, one of the main outcomes of insurance is
financial assistance to health organizations, fire departments, educational institutions, and other
organizations involved in preventing mass losses due to death or destruction.

• Source of capital
Insurance is a source of capital for society. The cash accumulated is put into the productive
channel. With the help of insurance investments, the death of society's capital is reduced to a
greater extent. The insurance industry, businesses, and individuals all profit from the insurers'
investments and loans.

• Efficiency in productivity
The function of insurance is to relieve the stress and anguish associated with death and
property destruction. A person can devote their body and soul to better achievement in life.
 • Contribution to economic progress
Insurance offers an incentive to work hard to better the people by safeguarding society against
massive losses of damage, destruction, and death. The people also provide a large amount of
capital, the next factor in economic advancement. Property, valuable assets, people, machines,
and society are unlikely to suffer significant losses due to calamity.

• Tool of investment and saving money

When you purchase an insurance policy, the insurance provider encourages you to install the
insurance system. This eases the process of understanding how insurance works and the
process of paying premiums.

• Source of foreign exchange

Insurance known as Overseas Medical Insurance Scheme for Indians Travelling Abroad for
Business and other purposes (OMIS) can be purchased. This can be purchased in Indian
currency. On the other hand, Overseas Mediclaim Insurance Scheme for Employment and
Studies [OMIS(E&S)] can be purchased in foreign currency. Therefore, this acts as a source of
foreign exchange where individuals traveling outside the country can use insurance as well.

• Subrogation
Insurance policies usually have a subrogation clause which is defined as a right held by insurance
carriers to legally pursue a third party who is responsible for the injury of the insured. Through this
process, the insurance amount to be claimed can be recovered to cover the losses by the insurance
carrier to the insured.
What are the Benefits of Insurance?
There are several roles and importance of insurance. Some of these have been given below:

• Insurance money is invested in numerous initiatives like water supply, energy, and
highways, contributing to the nation's overall economic prosperity.

• Rather than focusing on a single person or organization, the danger affects various
people and organizations.

• Insurance protects you and your family from various risks that could otherwise put you or
your family in financial jeopardy.

• It encourages risk control action because it is based on a risk transfer mechanism.

• Insurance policies can be used as collateral for credit. When it comes to a house loan,
having insurance coverage can make obtaining the loan from the lender easier.